“Bankruptcy – a fate worse than debt” (Anon)
One of a Body Corporate’s fundamental duties is to collect monthly levies from the scheme’s members, and to take robust action to recover any arrears. As with any other creditor/debtor relationship however, trying to recover debt can be an exercise in frustration and delay, and the more recalcitrant the debtor, the greater the temptation to “go straight for the jugular” by applying to sequestrate the debtor’s estate.
You will have to show that the sequestration is to the advantage of creditors as a whole – not just to you – but that isn’t the only consideration. You will be throwing good money after bad if you end up having to pay a “contribution to the costs of sequestration”.
The recent case of a sectional title Body Corporate, which perhaps thought that it was protected from this particular danger because of its statutory preferences for recovery of arrear levies prior to transfer, illustrates the danger.
But before we get to the facts and the outcome of that case let us have a quick look at the general principles involved.
What is a “contribution to costs” and who has to pay it?
If you want to share in the net proceeds of an insolvent estate, you must formally prove your claim at a meeting of creditors convened by the trustee of the insolvent estate. If you do not do that, you wave goodbye to any possible dividend and will be writing off the debt.
On the other hand, if you decide to prove your claim you may be at risk of having to pay into the estate as well as writing off the debt – talk about adding insult to injury! That danger arises if the costs of sequestrating the estate exceed the funds in the estate available to pay them. In that event the trustee of the insolvent estate will recover a “contribution to costs” from proved creditors – including you if your claim was proved as above.
The special danger of being the “petitioning creditor”
The creditor who applies for the debtor’s sequestration is – as “the petitioning creditor” – liable to contribute to the shortfall even without proving a claim. In other words, unlike other creditors, you cannot protect yourself from contributing to costs by holding back the claim – you are “deemed” to have proved it. That is why, although applying for sequestration can be an excellent way of recovering debt from a recalcitrant debtor, it is essential to first consider the danger of contribution.
How “secured creditors” can protect themselves
Also relevant to our story is that a creditor holding security (such as a bond over the insolvent’s property) must prove its secured claim in order to be paid out the net proceeds of its security. A secured creditor can, if it suffers a shortfall after being paid out those net proceeds of its security, also share in the “free residue” of the estate. The “free residue” is the net proceeds of all unencumbered assets available for distribution to creditors. The secured creditor’s share in this event will be based on the “concurrent” portion of its claim, in other words it is now a concurrent creditor.
This is where the danger comes in because any contribution payable is payable in the free residue by concurrent creditors. A secured creditor can largely protect itself from this danger by “relying on the proceeds of its security” to satisfy its claim. By doing so it waives its concurrent claim for the shortfall, but equally it no longer has to contribute along with the other proved (or petitioning) concurrent creditors. It will now only have to contribute when there are no other such creditors, or when other contributors are unable to pay their share.
The case of the Body Corporate that sequestrated to recover arrears – and paid the price
Let us see how those principles were applied in a recent Supreme Court of Appeal (SCA) case –
Bodies Corporate beware!
The Court’s reasoning in reaching this conclusion will be of great interest to the lawyers amongst us, but the bottom line for Bodies Corporate is this – if you sequestrate to recover arrears, you could well end up carrying the full brunt of any contribution to costs.
So perhaps take advice on whether you can/should rather use other debt collection processes, including perhaps applying to the CSOS (Community Schemes Ombud Service) to order and enforce payment of the arrears.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)